Monday, December 3, 2012

Understanding the risks in FMP

Risks in FMP are to be understood clearly before we start investing:
 
Default Risk : Bank Fixed deposits are considered less risky, as the depositors do not take the risks on the investments and loans created out of the deposited funds. The risk is transferred to the Bank. In case of FMP, the money is as good as the investment generated out of the funds. Here risk is retained.
 
Liquidity risk : Normally Banks, permit you to terminate the contract prematurely, at their own discretion, to maintain an image of liquidity and to satisfy the depositor. In case of FMP, it is closed ended mutual fund and hence can be carried till maturity. There are provisions to get them listed in the stock exchanges, to provide liquidity. However such listings do not guarantee liquidity, as there may not be takers.
 
Still, FMP is a good investment, if you do not need the money before the maturity date, as the provide better returns than the fixed deposit in bank. The default risk is minimised by the Fund manager by investing in the debt instruments which have a highest/higher ratings. A  13 month FMP, minimises the default risk as the tenure is shorter and rating downgrades on the investment is almost NIL during such a short period. It is imperative to read the offer documents to know where your fund proposes to invest. If investments are to be made in highest rated instruments, then you can consider the default risk to be almost zero.
 
To offset the liquidity risk, invest only such monies which you do not need for the prescribed period. Through this process, you can eliminate the liquidity risk.
 
Despite these apparent shortcomings, in the Indian context, the biggest attraction in FMPs are TAX TREATMENT. The income from fixed deposit is considered as your income  for the purpose of taxation and tax will be deducted at source, in case income exceeds the prescribed limit in a financial year. In case FMP, in a growth scheme, the return is treated as gains from short term/long term investments ( depending on the period of holding) and accordingly taxed. You  can choose the indexation benefit and can lower your taxation. This results in better yield on the investments. Many of the high tax bracket individuals prefer the taxation advantage over the risks outlined, which can be minimised substantially.
 
We will amplify the taxation advantage in our next post.

Sunday, December 2, 2012

Fixed Maturity Plans

What are they? Fundamentally they are akin to Fixed deposits with the bank, but offerings from a mutual fund.

A comparison between the two: (  Bank Fixed deposits and Fixed maturity Plans)

Similarities:


  • Investments for a definite period.
  • Avialable for various terms.
  • Have choices for periodical returns and cumulative returns.
  • Suitable for low and moderate risk takers.


Differences:

  • FDs are issued by banks and FMPs are issued by mutual funds.
  • Return is known and assured  in case of FDs at the time of placing the deposits, but not known and assured in case of FMP, even though indicated.
  • Default Risk is transferred to Banks in case of Fixed deposits and retained by the investor in case of FMP.
  • Return from Fixed deposit is treated as income in Income tax assessments whereas treated as gain on investments in case of FMP.



Saturday, December 1, 2012

Back to the world of mutual funds.

Returning back to the arena of mutual funds, after a long gap of six years. Was immersed in the Training  industry. Do you know training needs a lot of reading? It takes away most of your time. Despite being a trainer for the past six years, initial two to three minutes are always nervous seconds  ( is it good or bad?). Have decided to renew my learning through sharing once again. You will observe interesting articles on mutual funds curated, individual articles and comments which attracted my attention, besides continuing my thoughts on mutual fund industry which has grown and still growing.

Some of you may not like the ups and downs of the equity market. Those of you agreeing with this observations, in India, normally resort to banks for parking their savings. Is banking ( whose scenarios have changed from 1990, with more private ownership banking beckoning you from every corner of the city/town) is the only resort to those who wish to have a less risky investment? ( about" risk" on some other day).

 The other options are:

1. Government of India Bonds.
2. Debt mutual funds.
3. Company Debentures
4. Company Fixed deposits.
  and one more......
Fixed Maturity Plan.

We will be discussing about fixed maturity plan in later posts...
 Happy week end.